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From the Editor

Connect with MMG

ONLINE middlemarketgrowth.org LINKEDIN Middle Market Growth Magazine TWITTER @ACG_MMG

A Glimpse into the Future A

ANASTASIA DONDE Senior Editor, Middle Market Growth adonde@acg.org

s we were gathering data and commentary for this issue toward the end of 2023, the outlook for 2024 appeared slightly brighter. Private equity investors said they were seeing more deal flow, activity was starting to pick up and, according to an ACG survey, investment professionals were anticipating a livelier dealmaking year. For most of 2023, conditions worsened for M&A and new adverse events kept dealmakers at bay. Fears of a recession, rising interest rates, growing geopolitical tensions, the regional banking crisis in the spring and the aftershocks of the COVID-19 pandemic all poured cold water on an already slow market. It wouldn’t be unreasonable to expect new challenges at the end of the year or beginning of 2024 to throw things in limbo again. But what’s interesting now is that investors say they’re getting on with M&A despite persistently unfavorable conditions. Interest rates are expected to remain high for some time, industry experts are split on whether a recession is still coming, and the conflicts in the Middle East are worsening as this issue goes to print. At the same time, LPs are increasingly pressuring their private equity managers to return capital. Some say sellers’ valuation expectations are coming down to earth, more bank and non-bank lenders have launched new vehicles for debt financing in recent months, and boutique investment banks are hiring to prepare for more deal flow. As firms get ready for a rebound, they are increasingly tapping different avenues for growth. Our cross-border M&A story on pg. 26 highlights various firms’ efforts to invest abroad, raise dedicated European funds and open offices overseas while opportunities are lighter than usual in the U.S. The lending-focused article on pg. 36 also explores different avenues investors can pursue to finance deals. Among private credit funds, business development companies and banks, there is an abundance of lenders in the market, with some offering more leverage and others cheaper rates. But at times like these, credit quality is top of mind for debt providers who are wary of potential defaults or write-downs. Looking further into 2024, investors are thinking about the U.S. presidential election and the changes that might bring about for the dealmaking community. Some say they are trying to get deals done before the potential change of command, which could create another rush to close deals before the end of the year, like the one we saw in 2021. We hope some of the predictions in this issue prove to be true. And whichever way the market turns, we look forward to engaging with our readers on M&A trends, news and data in the year ahead. //

MIDDLE MARKET GROWTH // Special Edition

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Contents MIDDLE MARKET GROWTH // MULTIPLES REPORT

CEO Brent Baxter bbaxter@acg.org SENIOR VICE PRESIDENT, ACG MEDIA Jackie D’Antonio jdantonio@acg.org CONTENT DIRECTOR Kathryn Maloney kmaloney@acg.org SENIOR EDITOR Anastasia Donde adonde@acg.org DIGITAL EDITOR Carolyn Vallejo cvallejo@acg.org SENIOR ART DIRECTOR Michelle Bruno mbruno@acg.org VICE PRESIDENT, SALES Kaitlyn Gregorio kgregorio@acg.org

FEATURES

Printed in the United States of America.

8 Middle-Market Dealmakers Prepare for a Rebound Brought to you by S&P Global Market Intelligence

ISSN 2475-921X (print) ISSN 2475-9228 (online)

The year ahead looks promising for dealmaking, as sellers’ valuation expectations come down and booming sectors like healthcare services and information technology attract enthusiastic buyers.

18 Insights from S&P Global Market Intelligence

S&P offers a data-driven look at the 2023 global M&A dealscape.

middlemarketgrowth.org

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Contents

26 8

20 On the Horizon: Challenging Market Brings Seller Opportunities

Analysis from GF Data reveals how creative deal structuring can help win deals, even in the toughest environments.

24 Industry Spotlight: Manufacturing Brought to you by GF Data and Grata

A look at the state of the middle-market manufacturing sector, including valuations, deal activity, the opportunity set for buyers and more.

26 Cross-Border M&A Looks Ready for Takeoff in 2024 Brought to you by G-P

Faced with limited opportunities in their home market, U.S.-based dealmakers are increasingly looking at businesses in other low-risk countries as a path to growth.

34 Insights from Grata

It's time to rethink how multiples are calculated and build a deeper perspective of a company's valuation. Here's how.

middlemarketgrowth.org

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56 36 Investors Weigh Financing Options as M&A Improves

48 Reps and Warranties Insurance Evolves with the Deal Market

44 Industry Spotlight: Business Services

56 Investment Bankers Chart a New Path

Thanks to enthusiastic interest from investors and a gap left by traditional lenders, private credit is having a moment and offering sponsors a range of flexible capital solutions.

Brought to you by GF Data and Grata

Intelligence from GF Data and Grata reveals the state of M&A involving business services and IT services companies, including the number of independent businesses in the market and pricing trends.

As it continues to mature, the reps and warranties insurance market is extending its reach to a broader set of deal types, adapting to price fluctuations and grappling with how to settle claims.

Large investment banks made headlines last year as they laid off staff, even as their mid-market and boutique counterparts added to their headcount—a trend expected to continue into 2024.

MIDDLE MARKET GROWTH // Special Edition

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NOTES

Methodology T

he Middle-Market Multiples Report looks at the state of M&A and the outlook for 2024. The reported articles in this edition draw on perspectives of industry participants, gleaned through interviews. The articles also cite data from several key sources.

2024 MIDDLE-MARKET OUTLOOK SURVEY

ACG conducted a survey online between Aug. 17 and Sept. 18, 2023, for use in this report. Participants were asked about their expectations for M&A activity, key deal terms, leverage levels, valuations, hiring and more. Distributed via email and on middlemarketgrowth.org and social media, the survey collected input from a cross-section of middle-market M&A professionals—including accountants, attorneys, corporate strategic acquirers, family offices, investment bankers, lenders, limited partners, private equity firms and advisors. There were 261 complete responses to the survey. In several instances in this report, a smaller subset of the survey responses is cited—for example, responses from investment bankers are used in a story about hiring within investment banking. Those instances are noted; all other uses of the survey data reflect the responses of all 261 respondents.

GF DATA REPORTS

GF Data collects information on private M&A transactions ranging from $10 million to $500 million, as reported by more than 300 active contributing firms. The Multiples Report references various GF datasets, including from its M&A and Leverage reports, and sector-specific data. GF Data, an ACG company, publishes quarterly reports on middle-market trends and dynamics. Its proprietary data is submitted on a blind, no-name basis. Contributing PE firms can access GF Data for internal reporting to LPs and gain reliable market benchmarks in negotiation. Learn more at gfdata.com.

OTHER DATA SOURCES

This report also uses data from outside sources, which are credited accordingly. A NOTE ABOUT OUR SPONSORS: Two of the editorial feature stories in this report are underwritten by ACG sponsors—G-P and S&P Global Market Intelligence. Their sponsorship provided financial support for this report; however they were not involved in the production of those feature stories. //

middlemarketgrowth.org

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BROUGHT TO YOU BY

Middle-Market Dealmakers Prepare for a

Rebound M&A experts are hopeful that 2024 will be a more fruitful dealmaking year, as seller valuation expectations begin to come down BY BRITT ERICA TUNICK

Illustration by Rob Dobi

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2024 M&A OPPORTUNITIES

W The number of opportunities, pitches, proposals and engagements that our transactions teams are working on have meaningfully increased since roughly the second week of August. …Many of those deals will be going to market in 2024. MICHAEL MILANI Executive Managing Director and Principal, Baker Tilly

hen New York City’s famed crystal ball dropped in Times Square on New Year’s Eve, millions of people watched as it heralded the start of 2024 and the blank slate of a new year. But long before the ball fell, experts within the M&A industry were looking into their own proverbial crystal balls to predict what the mergers and acquisitions landscape will look like in the year ahead. There are some significant differences in what dealmakers anticipate for 2024, yet a common expectation shared by all is that it will be a year of change—and largely for the better. According to the results of a survey of the ACG community, 55% of respondents expect an increase in deal activity in 2024, 27% expect activity will remain much the same as 2023, and only 18% anticipate a decline. Following a year and a half of paltry M&A activity, due primarily to high interest rates, inflation, fears of a recession and a major disconnect between buyers and sellers regarding portfolio company valuations, there are widespread expectations that the floodgates will finally begin to open in 2024. “We’re not in the business of sitting on the sidelines. We’ve remained extremely active over the past two years, having closed on three platforms and multiple add-ons. We’re in the business of buying and selling companies and doing deals, and I expect 2024 will be a good year,” says Tad Nedeau, a co-managing partner at PE firm Lincolnshire Management and head of the firm’s origination team. In fact, he says it would not be surprising to see a similar deal trajectory to what occurred after the 2008 credit crisis. “We saw this in ’08-’09, where in the following years, deal volume picked up. And I think we’re going to see that here again,” says Nedeau. His sentiment is shared by Trent Hickman, a managing director at structured credit firm VSS Capital Partners: “The last year or so, particularly the last six months since the fall of SVB (Silicon Valley Bank), has been rough from an M&A perspective. Things have been really slow and the lending markets were largely shut for several months during the spring and summer. … But I think we’re starting to come out of this, and 2024, 2025 and 2026 should see an increasing amount of exit volumes.”

middlemarketgrowth.org

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Middle-Market M&A Activity Outlook

Dealmakers weigh in on expectations for how 2024 will compare with 2023 More deal activity

55.2%

Less deal activity

17.6%

About the same

27.2% 0

% of Respondents

2024 Valuation Predictions

How will valuation multiples in 2024 compare with 2023?

8.8%

Multiples will fall Multiples will rise

37.2%

% of Respondents

Multiples will remain at similar levels

54% Source: ACG’s 2024 Middle-Market Outlook Survey

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2024 M&A OPPORTUNITIES

GETTING OFF THE SIDELINES

Such prognostication is more than just wishful thinking and is backed up by positive signals in the market. “An increasing number of privately held companies, family-owned businesses, strategic sellers and private equity sellers are getting quality of earnings reports done in advance of a sale process,” says Michael Milani, an executive managing director and principal with Baker Tilly, an advisory, tax and assurance firm. “The number of opportunities, pitches, proposals and engagements that our transactions teams are working on have meaningfully increased since roughly the second week of August. … Many of those deals will be going to market in 2024.” While the onset of the COVID-19 pandemic ground M&A activity to a halt for a large part of 2020, the following year saw a record number of deals completed after the Federal Reserve reduced interest rates to record lows. Countless PE firms rushed to execute M&A deals of varying levels of quality. Once the pendulum swung in the other direction, however, as the Fed sought to control inflation through repeated interest rate hikes, deal activity plummeted. M&A activity has steadily declined since the start of 2022, due to higher debt costs, fears of recession and a sudden halt in fundraising as limited partners grappled with private equity-heavy portfolio allocations. In 2021, a total of 1,839 M&A deals were completed in the middle market with a combined value of $878.3 billion, according to data from PitchBook. Comparatively, 1,307 PE exits valued at a combined $321.5 billion took place in 2022. Activity and deal values have continued to drop, with only 378 middle-market M&A transactions completed in the first half of 2023 with a combined value of $139.6 billion. But following the lengthy lull in M&A activity, a lessening of the denominator effect and PE firms’ collective need to begin returning money to LPs, industry experts are optimistic that change is beginning. Not only is deal flow expected to pick up in 2024, so too is the overall quality of companies brought to market. Exits largely dried up since the start of 2022, and PE firms have found themselves holding portfolio companies much longer than anticipated. Absent opportunities to cash out of these companies, firms have taken a more hands-on operational approach with their holdings than they are typically able to do. “As long as you’re holding companies, you’re trying to create value in them. So, there’s been a lot of focus on improving the operations of businesses,” says Justin Green, a partner and co-head of flagship funds for PE firm Palladium Equity Partners. The result has been an overall improvement in the quality of many of the portfolio companies that firms will soon be bringing to market.

I honestly believe that the vintage fund years over the next three years in private equity are going to be some of the best returns over the next decade. SASH RENTALA Partner and Head of Financial Sponsors, Solomon Partners

COMING TO TERMS ON VALUATION

The quality of targets coming to market, combined with lower prices, bodes well for future investment returns. “I honestly believe that the vintage fund years over the next three years in private equity are going to be some of the best returns over the next decade,” says Sash Rentala, partner and head of financial sponsors at investment bank Solomon Partners. Prices are expected to come down as sellers accept that the valuations of 2021 are a thing of the past. Until recently, there has been a major disconnect between the value that sellers and buyers ascribe to companies positioned for sale, which has stymied transactions. Rentala

middlemarketgrowth.org

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Middle-Market M&A Outlook by Deal Type

The types of transactions that dealmakers expect to see more of in 2024 compared with 2023

Add-on acquisitions

67.4%

Distressed or restructurings

47.1%

Platform acquisitions

36.8%

Corporate carve-outs

24.1%

Non-control investments

16.1%

Leveraged recapitalizations

12.6%

Take-private acquisitions

11.9%

Secondary buyouts

10.7%

Other

1.5%

% of Respondents

Respondents could select more than one option. Source: ACG’s 2024 Middle-Market Outlook Survey

MIDDLE MARKET GROWTH // Special Edition

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2024 M&A OPPORTUNITIES

says he has heard from clients that roughly 75% of deals launched in 2022 never got done. That disconnect is not completely gone, but Rentala says that by the third and fourth quarters of 2023, many PE firms had turned their attention to selling off their “B” assets— mature holdings they’ve held on to for up to five years—with more flexible pricing, in an effort to return some capital to LPs. Some firms reintroduced hung deals in hopes that buyers would recognize the value from the additional time and attention PE firms have given to these companies. “There’s been a lot of holding out, to a certain extent, because sellers are looking at valuations and models that probably made sense at 2021 levels. … But those expectations are unrealistic,” says Chris Sheaffer, a partner at law firm Reed Smith and global vice chair of the firm’s private equity group. Many sellers continue to believe their companies are worth more than buyers are willing to pay, but Palladium’s Green says the valuation gap is finally beginning to narrow. When looking at the lower end of the middle market, though, valuations have actually held steady or risen. In the third quarter of 2023, average multiples on EBITDA rose to 7.5x from 6.7x in Q2, according to GF Data, which tracks transactions with $10 million to $500 million in enterprise value. Once activity finally begins to pick up and PE firms can start cashing out of their second-tier holdings, industry experts believe firms will unload some of their weaker holdings at bargain prices to get them off their books.

KEEPING ON WITH THE ADD-ON

Of the deals that made it to market in 2023, a sizable share were add-ons and platform deals financed largely with equity. Credit deals remained few and far between, and those that did come to market attracted significant competition. “Add-ons are a way for us to continue to transact and deploy capital despite the uncertain times and the low M&A activity,” says Brian Crosby, a managing partner at PE firm Traub Capital. He says firms can use portfolio companies to buy add-on acquisitions at attractive prices and lower multiples using existing debt facilities. Those sentiments are largely echoed in ACG’s survey findings. Asked what types of deals they expect to see in 2024 (with the ability to select multiple options), respondents ranked add-on acquisitions at the top of the list (67%), followed by distressed or restructurings (47%), platform acquisitions (37%) and corporate carve-outs (24%). When it comes to expected debt levels for PE transactions in 2024,

Buyers and sellers know that the price is the price and nobody’s going to lean way over their skis. CHRIS SUGDEN Managing Partner, Edison Partners

40.2% of respondents expect leverage will remain about the same as 2023, 39.5% expect that leverage levels will fall from 2023, and 20.3% anticipate higher leverage levels. The private equity industry has begun bracing for deal activity to ramp up again in 2024, yet there is less certainty about how quickly M&A activity will surge. “Once there is a signal that there is a little bit of clarity and stability in the markets, I think there’s going to be a massive resurgence of not only deal volume but deal quality. And everyone’s going to be trying to push through the exit door at the same time,” says Crosby. “But even if there is a surge and a return to quality, I don’t think that multiples are going to revert immediately. There will be such a supply of these companies coming at once that it will help temper rising valuation multiples.”

middlemarketgrowth.org

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Mid-Market Deal Volume and Valuation All Transactions

Q4 2021

Q1 2022

Q2 2022

Q3 2022

Q4 2022

Q1 2023

Q2 2023

Q3 2023

Number of deals

195

100

TEV (total enterprise value)/ EBITDA

7.8x

7.7x

7.4x

8.2x

6.9x

7.6x

6.7x

7.5x

Total debt/EBITDA

4.0x

4.1x

4.0x

3.9x

3.8x

3.7x

IN-DEMAND INDUSTRIES

When it comes to the outlook by sector, less cyclical areas such as healthcare services and information technology—particularly healthcare IT companies—top the list of those that industry experts expect to garner more attention from dealmakers. Pharmaceuticals is expected to remain a strong sector, as are artificial intelligence applications, particularly businesses that have real-world utilities for AI. Certain niche areas are also expected to do well. Palladium’s Green notes that his firm has been actively investing in businesses that serve the Hispanic community, which he says is growing faster than the overall U.S. population and has become an increasingly important part of the macro landscape. “If you were to look at the U.S. Hispanic market as if it was its own country, it would actually be the fifth-largest county in the world in terms of GDP, behind only the U.S., China, Japan and Germany,” says Green. “It’s a huge market that’s becoming increasingly important, and that’s a big focus area for us.” Conversely, businesses that have fallen out of favor include those in the consumer and retail sectors, specifically discretionary goods and services. The outlook is less clear for businesses that were directly impacted by the pandemic-era lockdowns and supply chain issues. Though remote communications, home improvement and decorating businesses got a major boost during COVID, and the travel and hospitality industries struggled, things have changed as the pandemic has receded. “In a lot of cases, many businesses that were really frothy 18 months ago are having a hard time now, and valuations are coming down,” says Randi Mason, a partner at law firm Morrison Cohen and co-chair of the firm’s corporate department. “It’s still hard to price those businesses because it’s hard to project how they are going to do in the long term in a post-COVID environment.” She adds that

Source: GF Data

MIDDLE MARKET GROWTH // Special Edition

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2024 M&A OPPORTUNITIES

fragmented industries, such as the medical and dental sectors, are particularly attractive to investors, who see the potential of consolidation and roll-ups.

PERSISTENT CLOUDS

Once there is a signal that there is a little bit of clarity and stability in the markets, I think there’s going to be a massive resurgence of not only deal volume but deal quality. BRIAN CROSBY Managing Partner, Traub Capital

Despite the many opportunities that dealmakers see ahead, the industry is cognizant of myriad factors that could dampen the expected surge of deal activity. Macro issues such as the ongoing wars in Ukraine and the Middle East, along with any unexpected move by the Fed to raise interest rates further and, of course, the 2024 presidential election, are high on firms’ radar. “When you look at what happened in the last election—and there’s no reason to assume this one will be any different— everyone lost their minds and we had a two-to three-month period of uncertainty,” says Chris Sugden, a managing partner at growth equity firm Edison Partners and chairman of the firm’s investment committee, noting that uncertainty and the damper it put on deal activity could be even worse this time around, depending on which candidates ultimately end up on the ballot. He expects firms will try to complete as many deals as possible in the first half of 2024. Regardless of when deal activity finally picks up, there is a contingent that believes the struggles the M&A community has faced over the past couple of years haven’t been all bad. “Indigestion is actually healthy, because everyone’s sort of got religion now,” says Sugden. “Buyers and sellers know that the price is the price and nobody’s going to lean way over their skis. And, in general, people still feel like the highest quality assets will still get a higher valuation and are not being punished for other people’s bad outcomes or bad management.” Reed Smith’s Sheaffer adds: “Even though this last year was on the slower end, we think it was probably needed to reset some of the market expectations, and we’re confident that we’re going to end up in a very healthy M&A market in the next several years.” // BRITT ERICA TUNICK is an award-winning journalist with extensive experience writing about the financial industry and alternative investing.

O c c D s o

middlemarketgrowth.org

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Insights provided by:

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The Big Picture:

Visualizing the 2023 Global M&A Dealscape

Third quarter global M&A activity continued its decline from the highs seen in 2021. The total year-to-date deal value was at its lowest level since 2020, just over $1 trillion. Market participants still contended with macro issues including inflation, higher financing costs, increased regulatory scrutiny, and ongoing armed conflict. While overall deal values declined 15% quarter-over-quarter, the less volatile middle market only experienced a 4% decline. Mega deals did see a resurgence, but large deal activity still declined 20% from Q2 2023. As for sector activity, Energy led the way with an average deal size of $268M in Q3 2023.

Global M&A Activity

Deal Volume

$4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 0

slaeD fo rebmuN

40,000 13,383

10,000

7,342

12,947

11,559

10,216

12,498

12,276

30,000 20,000

14,754

9,998

2020 Q1

11,212

12,734

10,949

2021

)nB$( eulaV noitcasnarT

50,000

2022

7,653 9,262 9,957

2023

Deal Value ($Bn)

$998.74 $1,057.02

$582.84 $470.21

$1,045.73 $1,067.62

$739.61 $290.02 $483.70

2021

$529.93 $419.13

$673.01

$992.42

2020

$451.34

$909.61

2022

2023

Large Deals vs. Middle Market Deals

Deal Value ($Bn)

)nB$( eulaV noitcasnarT

1000 800 600 400

$700

200 $276 0

$208

$157 $133

$529 $211

$346

$734 $260

$740 $328

$733 $324

$613

$386

$418

$654

$249

$368

$255

$256

$222

$215

$265

$375

$154

$155

$303 $149

Q1'20 Q2'20 Q3'20 Q4'20 Q1'21 Q2'21 Q3'21 Q4'21 Q1'22 Q2'22 Q3'22 Q4'22 Q1'23 Q2'23 Q3'23 $0 - $1bn

$1bn+

Deals without reported transaction value excluded from chart

Data as of Oct. 5, 2023. Analysis includes global public common and convertible preferred equity issuances completed between 1/1/20 to 9/30/23. Excludes private placements and blank-check blind pool companies. Aggregate amount offered includes overallotments. M&A data includes announced or completed deals between 1/1/2020 and 9/30/2023, where the buyer acquired a majority stake in a company or asset. Source: S&P Global Market Intelligence.

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See the Big Picture Read our 2024 industry outlook reports >

Volatility in Shifting Deal Multiples by Sector

Average of Implied Enterprise Value/ EBITDA (x)

Deal Multiples

30 25 20 15 10 5 0 Communication Services

Energy

Healthcare

Q3'21

Q3'22

Q3'23

Information Technology

$268.3 $192.6 $107.6 $89.5 $74.4 $72.8 $62.0 $46.8 $39.2 $37.8 $30.5

Financials Healthcare Consumer Staples Materials Information technology Real estate Communication Services

04.932$ 7.732$

31.401$ 5.9$

32.39$ 1.71$

62.8$ 0.97$

43.5$ 9.39$

ad a na C&

.S. U

& a cir em A nit aL

tsa E eld diM

na e bb ira C

ep or uE

cif ic a Pais A

ac irf A

Q3 2023

Real Estate

Q3 2023

Energy

Q3 2022

Materials

Financials & Utilities sectors excluded due to lack of reported values

Utilities

99.0$ 8.6$

)nB$( eulaV noitcasnarT

$240 $220 $200 $180 $160 $140 $120 $100 $80 $60 $40 $20 0

Industrials

Average Deal Size by Sector

Transaction Value ($Bn) by Region

y or

Consumer Staples

Year-Over-Year M&A Activity

3 9

hart

Consumer Discretionary

Consumer Discretionary Industrials 0

$40

$80

$120

$160

$200

$240

Transaction Value ($M)

$280

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Data as of Oct. 5, 2023. Includes announced or completed deals between 1/1/2020 and 9/30/2023, where the buyer acquired a majority stake in a company or asset with the target’s geographic location and primary industry disclosed. Source: S&P Global Market Intelligence. Important Copyright Notice: Copyright © 2023 by S&P Global Market Intelligence, a division of S&P Global Inc. All rights reserved. No content, including by framing or similar means, may be reproduced or distributed without the prior written permission of S&P Global Market Intelligence or its affiliates. The content is provided on an “as is” basis. If you wish to distribute this information, contact: market.intelligence@spglobal.com

02_Intro_SP_V2.indd 19

12/13/23 4:11 PM

ON THE HORIZON

Challenging Market Brings Seller Opportunities BY AUSTIN MADRONIC

iddle-market deal volume was down in the first half of 2023 by 23%, with GF Data reporting on 135 completed deals compared to 175 completed transactions in the first half of 2022. We have covered the causes of the slowdown extensively in our reports—including cost of capital and an uncertain economic environment—but in this article I’ll explain how creative deal structuring can help win deals even in the toughest environments. In the past, we have looked at deal terms for clues when we are unsure of how the market is going to proceed. For example, when deal flow spiked after the pandemic, the deal terms told us that 38% of companies with below-average financials garnered some sort of seller earnouts or financing in the deal. Meanwhile, just 39% of above-average companies received seller earnouts or financing. (GF Data classifies

reporting companies with greater than 10% trailing 12-month (TTM) revenue growth and at least a 10% TTM EBITDA margin as “above-average financial performers.”) Fast-forward to the first half of 2023, which witnessed a banking crisis and successive interest rate increases, and the script has flipped. We’re now seeing seller earnouts or financing in 42% of deals involving companies with below-average financials. The percentage of deals involving above-average businesses that received seller earnouts or financing also rose significantly, to 47%. The challenging market environment clearly is

Seller Rollover Equity (SRE): High End Projection by Total Enterprise Value (TEV) Range TEV

SRE %

Exit Multiple

YoY EBITDA Growth

Years Held

Exit EBITDA Margin

Exit Value of Rollover Equity

Entry Value of Rollover Equity

Growth of Rollover Equity ($m)

Growth on Total Sell Price

10 25 50 100 200 300 400 500

20% 20% 20% 20% 20% 20% 20% 20%

10 10 10 10 10 10 10 10

1.12 1.12 1.12 1.12 1.12 1.12 1.12 1.12

7 7 7 7 7 7 7 7

20% 20% 20% 20% 20% 20% 20% 20%

$8.84 $22.11 $44.21 $88.43 $176.85 $265.28 $353.71 $442.14

$2.0 $5.0 $10.0 $20.0 $40.0 $60.0 $80.0 $100.0

$6.84 $17.11 $34.21 $68.43 $136.85 $205.28 $273.71 $342.14

68% 68% 68% 68% 68% 68% 68% 68%

Seller Rollover Equity (SRE): Market Rate Projections by TEV Range TEV

SRE %

Exit Multiple

YoY EBITDA Growth

Years Held

Exit EBITDA Margin

Exit Value of Rollover Equity

Entry Value of Rollover Equity

Growth of Rollover Equity ($m)

Growth on Total Sell Price

10 25 50 100 200 300 400 500

15% 15% 15% 15% 15% 15% 15% 15%

7 7 7 7 7 7 7 7

1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1

5 5 5 5 5 5 5 5

15% 15% 15% 15% 15% 15% 15% 15%

$2.54 $6.34 $12.68 $25.37 $50.73 $76.10 $101.46 $126.83

$1.5 $3.8 $7.5 $15.0 $30.0 $45.0 $60.0 $75.0

$1.04 $2.59 $5.18 $10.37 $20.73 $31.10 $41.46 $51.83

10% 10% 10% 10% 10% 10% 10% 10%

middlemarketgrowth.org

03_On Horizon.indd 20

Source: GF Data

12/13/23 4:11 PM

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12/13/23 4:11 PM

ON THE HORIZON

driving more use of seller earnouts and financing, but it also appears to have fostered an environment that favors rollover equity as a bridge to getting deals done. In the first half of 2023, we saw more instances and higher amounts of seller rollover equity (12% of deals in the first half of 2023 compared to 9% over the last five years). While these deals require a greater financial commitment for the seller, they can often turn out to be lucrative for them—especially when the deal involves an above-average financial performer. When we look at the total value of a deal along with the typical return on investment at exit, a 15%-20% offering of seller rollover equity can lead to incredible value for the seller. The two charts detail examples of return on rollover equity upon exit at both a high and low end. At the high end, I assume a 10x exit multiple, with EBITDA growing year over year at 12%, a seven-year holding period and an EBITDA margin of 20% at exit. With these assumptions, the seller’s rollover equity upon exit has grown by 68%, with a multiple on invested capital (MOIC) of 4.42x and a 23.65% internal rate of return. At market rate, I assume a 7x exit multiple (approximately the current average multiple for all industries tracked by GF Data), with EBITDA growing year over year at 10%, a five-year holding period and an EBITDA margin of 15% at exit. With these assumptions, the seller’s rollover equity upon exit has still grown by 10%, with an MOIC of 1.69x and an 11.11% IRR. While these deal structures ramp up in the transactions that are being completed in a difficult buyer’s market, they have allowed TEV/Adjusted EBITDA multiples to remain relatively stable while not completely bringing deal flow to a halt. // AUSTIN MADRONIC is the research manager of GF Data, an ACG company. GF Data collects and reports on platform and add-on acquisitions completed by private equity funds and other deal sponsors in the $10 million to $500 million enterprise value range. For information on subscribing, or on contributing data as a private equity participant, contact us at info@gfdata.com.

GF Data and FORVIS Team Up For Roundtable Discussion Series GF Data, an ACG company, and FORVIS are pleased to announce they are partnering in the coming year to host two roundtable discussions covering trends in the middle market for technology and business services companies, and their impact on valuations and operational issues. These invitation-only sessions will bring together senior personnel in finance from portfolio companies as well as investment banking and private equity professionals working with these businesses. The roundtable discussions will begin with a review of GF Data’s quarterly data and will bring unique perspectives to the market analysis as well as FORVIS’ market-leading insights and forward vision in accounting, tax and consulting. The first GF Data/FORVIS roundtable will take place at ACG Atlanta’s M&A South 2024 conference in Alpharetta, Georgia, on Feb. 5 and will focus on technology and business services companies with a deep dive into valuations and operational issues. A second roundtable is planned for New York City in the summer. While attendance is by invitation only, please email Bob Dunn, GF Data’s managing director, at bdunn@acg.org for more information if you are interested in participating. GF Data offers the most accurate valuations on private equity-backed middle-market businesses valued between $10 million and $500 million. Through its network of more than 300 contributing private equity firms, independent sponsors, family offices and mezzanine investors, GF Data helps deliver clarity to the middle market through its quarterly reports and online searchable database. Visit gfdata.com to learn more. FORVIS, LLP is an integrated professional services firm with a global reach and a passion to drive businesses forward. The firm’s 6,000 dedicated team members provide an Unmatched Client Experience® through the delivery of assurance, tax and consulting services for clients in all 50 states and internationally. FORVIS’ dedicated private equity professionals cross multiple service lines to support middle-market firms, investment funds and their portfolio companies in several industries, including technology and business services. The firm tailors its approach based on client needs and routinely uses its deep global resources to develop strategies and services for clients’ success, now and in the future. Visit forvis.com to learn more. GF Data and FORVIS will also be at DealMAX 2024 in April in Las Vegas. We hope to see you there!

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03_On Horizon.indd 22

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12/13/23 4:11 PM

INDUSTRY SPOTLIGHT

Manufacturing Stems Its Slide in Q3 2023 S igns are pointing to a recovery in purchase price multiples for manufacturing investments in the middle market. Average valuations for manufacturing deals rebounded in the first quarter of 2023, according to recently published research from GF Data, in the midst of significantly low deal volume. At the end of the third quarter (at the time this article was written), valuation multiples for private equity- backed manufacturing deals with enterprise values between $10 million and $250 million averaged 6.7x trailing 12 months (TTM) adjusted EBITDA. This compares to 6.4x—the average through the first two quarters of 2023 and also the historical average since 2003. The multiple increases were seen across all deal sizes, save for transactions valued between $25 million and $50 million, which were flat at 6.8x. All other size cohorts were up approximately 2.5x year to date through the third quarter of 2023, versus the first half of last year.

However, deal volume for manufacturing transactions through the third quarter of 2023 was down a little more than 33% from the total for full year 2022, and 61% off the tally for 2021—which recorded the highest volume in more than five years. Debt coverage for manufacturing platform deals remained stuck at an average of 3.1x TTM EBITDA through 2023’s third quarter, the same mark achieved in the first half of 2023. Again, the $25 million to $50 million size tier saw erosion in coverage, dropping to an average of 2.7x through the third quarter compared to 2.8x, while debt coverage multiples for larger transactions rose slightly. All other size tiers improved slightly. It was a similar case for senior debt coverage for manufacturing deals, which held steady at 2.3x through the third quarter of last year with a small decline in deals valued between $10 million and $25 million, and modest improvements in coverage for transactions above that mark. //

Total Enterprise Value/EBITDA—Manufacturing ($10M-250M TEV) TEV ($M)

2003- 2018

2019

2020

2021

2022

YTD 2023

10-25 25-50 50-100 100-250 Total N=

5.6 6.0 6.9 7.5 6.2 1355

5.6 6.3 6.9 8.7 6.5 134

5.9 6.6 7.7 7.4 6.7 125

6.0 6.8 8.0 8.5 7.1 185

6.2 7.2 8.3 9.0 7.3 111

5.5 6.8 6.9 9.3 6.7 72

Total

5.7 6.3 7.2 7.9 6.4

776 588 424 194 1982

Total Debt/EBITDA—Manufacturing by Deal Size ($10M-250M TEV), Platforms Only

TEV ($M)

2003- 2018

2019

2020

2021

2022

YTD 2023

10-25 25-50 50-100 100-250 Total N=

3.2 3.4 3.8 4.2 3.5 793

2.8 3.6 3.6 4.5 3.5 97

3.0 3.2 3.5 4.1 3.3 81

3.0 3.4 3.8 4.1 3.6 129

3.3 3.3 3.9 4.4 3.5 62

3.2 2.7 3.0 3.8 3.1 55

middlemarketgrowth.org

04_CrossBoarder_Globalization_V2.indd 24

Total

3.1 3.3 3.7 4.2 3.5

413 370 288 146 1217

Source: GF Data

12/13/23 4:12 PM

Medical Equipment

Fragmentation by Top Companies

Fragmentation by ]inership

6% Medtronic

VC Backed

3% 3%

EssilorLuxottica Siemens Healthineers

4,570 1,774 2,263 2,156

Private Subsidiary

P Backed

81%

Pub ic

2% 4% 13%

60% 50,542

Independent

Boston Scienti(c Total Remaining

21%

Public Comps

Mean

$77.85B

$87.8B

$18.1B

$4.7B

5.砀

20.砀

Stryker Corporation

$107.1B

$117.8B

$19.9B

$4.9B

5.9 x

25.2 x

Medtronic

$95.9B

$113B

$31.6B

$8.3B

3.6 x

12.8 x

Boston Scientific Corporation

$78.7B

$87B

$13.8B

$3.5B

6.3 x

26.2 x

Becton, µickinson and Compan y

$68.4B

$82.9B

$19.4B

$5.1B

4.3 x

18.8 x

Edwards Lifesciences Corporation

$39.2ê

$38ê

$5.8ê

$1.7ê

6.5x

20.1x

Private Comps

Medline Industries, 倀

$16B - $25.㐀¼

36,5㐀Ï

20.6 %

Karl Stor z

$1.8B - $2.8¼

8,82 4

18 %

A FA HealthCar e

$1.6B - $2.㐀¼

10,17 7

-10.3 %

Hanger, Inc .

$1.1B - $1.6¼

5,61 2

7.㐀 %

Cordis

$692M - $1B

3,502

5.8

“Unlike legacy databases, Grata incorporates multiple factors into our employee estimates. Factors that will account for industries, like healthcare manufacturing, that do not have accurate employee estimates on LinkedIn.ß

Precedent Transactions

Tekni-Plex, Inc .

11/9/23

Seisa Medica l

1,52 7

89 %

Saville x

11/7/23

Envair Technolog y

3 2

3.2 %

Inari Medica l

11/1/23

LimFlow S A

9㐀 4

20 %

Amete k

10/31/23

Paragon Medica l

㐀,㐀9 9

10.6 %

Ergotron

10/30/23

Enovate Medical

㐀85

-1.㐀

04_CrossBoarder_Globalization_V2.indd 25

12/13/23 4:12 PM

04_CrossBoarder_Globalization_V2.indd 26

12/13/23 4:12 PM

BROUGHT TO YOU BY

Cross-Border M&A Looks Ready for

Takeoff in 2024 Investment targets outside of the U.S. offer a shot at expansion— even as geopolitical and regulatory risks present challenges for buyers BY DANIELLE FUGAZY

Illustration by Gary Waters

04_CrossBoarder_Globalization_V2.indd 27

12/13/23 4:12 PM

CROSS-BORDER M&A

A It’s all about the growth opportunity. When we invest in a company, they only have so much addressable market in the U.S. They have to find ways to expand. CHERYL STROM Partner, Origination, The Riverside Company

s U.S. dealmakers look to transact in a tighter M&A environment, some are venturing abroad to expand their universe of deals. They are finding these opportunities by leaning into new strategies, growing their presence outside of the United States and seeking add-on acquisitions in other countries. Higher interest rates made it more expensive to finance deals last year, prompting the slowdown in deal activity. At the same time, there’s been an uptick in interest in new avenues for growth. “Companies are more often looking at cross- border opportunities as they run out of acquisition targets in their own markets and seek growth,” says Alan Zoccolillo, chair of law firm Baker McKenzie’s North American Transactional practices. In Deloitte’s 2023 M&A Trends Survey, 29% of corporate and private equity leaders polled in fall 2022 said their organizations had “significantly increased interest” in investing in foreign targets, compared to just 17% in the prior year’s survey. Lexington, Kentucky-based middle-market private equity firm MiddleGround Capital is among the firms eyeing international opportunities. In 2023, the firm opened its first European office in Amsterdam. Meanwhile, in April, the mega firm KKR said it had closed its largest ever European buyout fund with $8 billion. For The Riverside Company, add-on investments have long been an effective path for entering new markets. Over its lifetime, the lower middle-market private equity firm has completed 94 cross-border deals through its portfolio companies—70 of them in the last decade. In 2018, the firm invested in U.S.-based Abracon, a specialty manufacturing and distribution business. During its ownership period, Riverside made four add-on acquisitions for Abracon, including two that were cross-border. In 2021, Abracon purchased ProAnt, a Swedish-based company, and AEL Crystals, headquartered in the U.K. “Abracon had not completed any add-on acquisitions before our investment. Our team helped management achieve their goal of expanding into Europe,” says Cheryl Strom, a partner on the origination team at Riverside. “It’s all about the growth opportunity. When we invest in a company, they only have so much addressable market in the U.S. They have to find ways to expand.” Of course, there are questions to ask before pursuing international expansion, such as whether a company’s offering is

middlemarketgrowth.org

04_CrossBoarder_Globalization_V2.indd 28

12/13/23 4:12 PM

Significant Increase in Cross-Border M&A Interest (Corporate and private equity) Significantly decreased interest in foreign targets

3% 0%

Decreased interest in foreign targets

9% 2%

No change in interest

19% 15%

Increased interest in foreign targets

51% 53%

Significantly increased interest in foreign targets

17% 29% 0

% of Respondents Fall 2021

Fall 2022

Source: Deloitte’s Navigating Uncertainty: 2023 M&A Trends Survey

Looking Farther Afield Regions of interest to U.S. investors 80%

74.1%

73.2%

60%

40%

34.8% 25.0%

20%

25.0% 12.5%

5.4% Africa

Asia-Pacific

Europe

Latin America

Middle East and North Africa

North America – Canada

North America – Mexico

Regional preferences from 112 respondents who said their firm will consider M&A opportunities outside of the U.S. in 2024. Respondents could select more than one region. Source: ACG’s 2024 Middle-Market Outlook Survey

04_CrossBoarder_Globalization_V2.indd 29

12/13/23 4:12 PM

CROSS-BORDER M&A

relatable overseas, or whether the new market is similar enough that end users will embrace the product, Strom adds. “Everything must be thoroughly considered before a cross-border investment, but it can be a good way to find growth.”

WHERE ARE DEALMAKERS HEADED AND WHY?

Today, many U.S. companies are focusing their deal activity on Canada, the U.K. and Europe. According to ACG’s recent 2024 outlook survey, respondents overwhelmingly said they would consider investments in Europe and Canada, with Mexico as a distant third location of interest. Portfolio companies of firms like Blue Point Capital, Clearlake Capital and Levine Leichtman Capital Partners have all recently done deals in various parts of Europe. In July, Law Business Research (LBR), a Levine Leichtman portfolio company, acquired MBL Seminars Ltd. Headquartered in London with offices throughout the United States and in Hong Kong, LBR provides business information, legal analysis tools and networking for global legal markets. In May, Clearlake Capital’s BBB Industries, a sustainable manufacturer in the automotive aftermarket, acquired Poland-based Inter-Turbo, expanding BBB’s presence in Europe following its 2022 acquisition of Budweg and several other companies across the continent since 2019. A few months prior, Blue Point Capital Partners and its portfolio company Next Level Apparel acquired Stedman, a designer, manufacturer and supplier of premium casual and blank sportswear for the printed apparel industry based in Germany. These transactions, along with the geographic interests expressed in ACG’s survey, reflect a growing preference among investors to expand into markets where the perceived political risk is low. “Cross-border transactions can happen in any number of geographies, but generally speaking, I think we, like many private equity firms, seek to work in markets that have a similar rule of law, and where there is less risk today,” says Strom. Deloitte’s survey results tell a similar story about the overseas markets that are most active for U.S. buyers. Compared with earlier patterns, U.S.-based corporate and private equity executives who responded to the survey expressed increased interest in cross-border deals involving stable, established economies, often close to their headquarters, including in Canada, the U.K. and parts of Europe. Nearly half (49%) of respondents to Deloitte’s fall 2022 survey expressed interest in Canadian targets, a 15-percentage point

increase from the year prior and the biggest gain for any single nation. Australia, Scandinavia and the U.K. each saw an 8-point increase in the percentage of U.S.-based survey respondents who noted acquisition interest in those locations. The emphasis on well-established economies marks a departure from the recent past. “This stands in contrast to previous year trends focused on the potential upside in developing nations—when there was more appetite for the associated risk,” Deloitte’s report notes. Zoccolillo similarly has observed a flight from regions perceived as high risk. “Cross-border activity between the U.S. and Europe has held on, and we are also seeing an uptick in Latin America as well,” he says. “What we are seeing less of is companies expanding in areas associated with more geopolitical risk.” One such area is China, which has experienced a significant pullback of U.S. private equity and venture capital investments in recent years amid geopolitical tensions and strict lockdown measures. In 2022, the aggregate value of U.S. PE and VC investments in China declined roughly 76% over the prior year, to $7.02 billion from $28.92 billion. The number of deals dropped by about 40%, to 208 from 346, according to S&P Global Market Intelligence data. Zoccolillo also points to Russia, from which companies continue to flee. According to a study by Yale School of Management, more than 1,000 companies have left or curtailed their operations in Russia. The Middle East is another region likely to see reduced investor interest,

middlemarketgrowth.org

04_CrossBoarder_Globalization_V2.indd 30

12/13/23 4:12 PM

Private Equity and Venture Capital Investors Chill on China DOWN

Deals in China with U.S. PE and VC Investors

40%

208 deals IN 2022

346 deals IN 2021

Value of U.S. PE and VC Investments in China

$7.02 billion IN 2022

$28.9 billion IN 2021

following the October attack on Israel by Hamas and continuing violence. “Recent events in the Middle East will also likely have a substantial impact on the transactional activity in those markets,” says Zoccolillo.

DOWN

76%

Source: S&P Global Market Intelligence

SECTOR SPECIFIC

Naturally, certain types of companies lend themselves more easily to non-U.S. markets. Strom notes that cross-border opportunities in manufacturing and distribution remain popular, as do software and pharmaceutical deals. According to PwC’s 2023 Key Themes Driving M&A Activity in Health Industries report, major pharmaceutical conglomerates are actively seeking M&A opportunities, including cross-border deals, to fill in their pipelines and achieve their growth plans, as patents for many top-selling drugs are scheduled to expire in the back half of the decade. Zoccolillo notes that pharma is among the subsectors poised for a cross-border M&A resurgence. “We operate in a number of sectors and are seeing them all pick up a bit, but pharma and energy will continue to be a little more robust. Pharma tends to be a little easier to expand globally than

MIDDLE MARKET GROWTH // Special Edition

04_CrossBoarder_Globalization_V2.indd 31

12/13/23 4:12 PM

CROSS-BORDER M&A

Cross-border activity between the U.S. and Europe has held on. ... What we are seeing less of is companies expanding in areas associated with more geopolitical risk. ALAN ZOCCOLILLO Chair, North American Transactional Practices, Baker McKenzie

healthcare services, which tend to be a bit more local or regional in nature,” he says. Still, cross-border healthcare deals outside of pharma are happening. One notable example is the United Arab Emirates-based healthcare platform Pure Health’s investment in U.S.-based Ardent Health Services for $500 million in 2022. Pure Health acquired the minority interest in Ardent, the fourth largest privately held health system in the U.S., from its majority owner, Chicago-based Equity Group Investments. Technology, meanwhile, has historically been a big driver of cross-border M&A, although that activity has slowed. “There has certainly been a dip in the number of tech transactions in the last year, but we are expecting that to pick up,” Zoccolillo says. Despite the lull, there have been some big cross-border M&A tech deals. One example is Fremont, California-headquartered Concentrix’s 4.5 billion euro acquisition of Paris-based outsourcing solutions provider Webhelp from Groupe Bruxelles Lambert. The transaction was one of the largest European deals of 2023. The difficulty of transacting across borders today ultimately depends less on the sector of the company involved and more on the regulatory environment, something dealmakers should be prepared for. “There is no industry that is problematic per se. Where we currently see challenges is with antitrust regulators. Regulators are talking to each other more than they did historically and are more coordinated than in previous years, which is leading to longer, more complicated and more expensive transactions,” says Zoccolillo. Companies that are strategically positioned to complete cross-border acquisitions will continue to be competitive, while others may struggle in the increasingly global marketplace. Yet even as investors tread carefully, signs point to continued activity for dealmaking across borders. “We are always surveying our portfolio companies and thinking broadly about the best ways to expand,” says Strom. “I think we will continue to see cross-border activity in 2024. We are certainly ready to transact.” // DANIELLE FUGAZY is a freelance writer who has covered private equity for more than 20 years. She is based in Glen Cove, New York.

middlemarketgrowth.org

04_CrossBoarder_Globalization_V2.indd 32

12/13/23 4:12 PM

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05_LendingSpotlight_V2.indd 36

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Investors Weigh Financing

Options as M&A Improves

With many new private credit funds, BDCs and bank direct lending arms in the market, private equity sponsors debate the merits of different capital providers

BY BAILEY M C CANN

Illustration by Gary Waters

05_LendingSpotlight_V2.indd 37

12/13/23 4:13 PM

LENDING SPOTLIGHT

R I think private credit and BDCs are going to be an increasingly important piece of the puzzle as the market continues to grow. PATRICK LINNEMANN Managing Director, Blue Owl Capital Corp.

ising interest rates, last spring’s regional banking crisis and other headwinds sent dealmakers and lenders to the sidelines for much of 2023, a year that saw a 44% drop in deal value and a 36% decline in transaction count in its first nine months compared with the same period in 2022, according to S&P Market Intelligence Data. The coming year looks brighter on the deal front. A majority of respondents to ACG’s 2024 outlook survey expect M&A activity to increase, although high interest rates and economic uncertainty remain top concerns. Lenders say capital is available for high-quality deals, thanks to a bustling private credit market—but riskier transactions are likely to face a harder path. “The bottom line is that rates are way higher,” says Ben Radinsky, a principal at alternative asset manager HighVista Strategies who focuses on opportunistic credit and special situations investing. “Spreads have been pretty consistent if you look at the past four years. But the net result is that the real cost of capital has increased dramatically, and it’s making some of the financings that were done over the past few years just impossible to maintain.” When it comes to accessing capital for M&A, most sponsors prefer working with private credit funds and business development companies (BDCs). “Sponsors generally are more inclined to go with these options because they need flexible capital and providers that are willing to offer leverage,” says Christine Tiseo, managing director on the debt capital advisory team at Lincoln International. “The additional 100-200 basis points of cost is outweighed by the certainty that they can get around closing in the private markets.” According to GF Data, bank lenders charged an average interest rate of 10.2% on senior loans for platform investments in the $50 million to $500 million enterprise value range in 2023 through Q3. By comparison, non-bank lenders charged 10.9% for similar deals.

‘A DREAM SCENARIO’ FOR PRIVATE CREDIT, BDCS

The ascendance of private credit and BDCs is being fueled by investors eagerly seeking new opportunities. The size of the private credit market at the start of 2023 was approximately $1.4 trillion, up from $875 billion in 2020. The market

middlemarketgrowth.org

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How do you expect interest rates to change in 2024 compared with 2023 levels? Interest rates will stay the same

62.8%

Interest rates will fall

21.8%

Interest rates will rise

15.3% 0

% of Respondents

How do you expect debt levels in private equity transactions to look in 2024 compared to 2023?

20.3%

40.2%

Leverage levels will remain about the same

% of Respondents

Leverage levels will fall Leverage levels will rise

39.5% Source: ACG’s 2024 Middle-Market Outlook Survey

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LENDING SPOTLIGHT

is projected to grow to $2.3 trillion by 2027, according to data from Morgan Stanley. “We’re in kind of a dream scenario for private lenders,” says Troy Gayeski, chief market strategist for alternative asset manager FS Investments. “We have to pinch ourselves a little bit because not only is the Fed going with ‘higher for longer,’ but the probability of a recession has dropped significantly. We also have a positive feedback loop from stable government spending, more business and more construction driven by the Inflation Reduction Act.” This creates an ideal environment for direct lenders, Gayeski adds, which stand to earn more income for longer at wider spreads and lower leverage levels. Steven Ruby, co-head of originated debt at investment firm Audax Private Debt, agrees. “We think this is going to be a very good vintage year for private credit,” he says. “When you zoom out and look at the asset class, it’s very easy to get 11%-12% coupons at a lower leverage ratio and a loan-to-value of 35%-40%. That’s a net positive for investors and lenders.” BDCs are also drawing investor interest. These closed-end investment companies, which lend to small and medium-size privately held businesses, are available to retail investors and can trade like stocks. “All types of investors are interested in having exposure to private credit almost as a core holding or a permanent holding, and for ultra- high-net-worth investors and retail investors, BDCs provide that avenue,” Ruby explains. BDCs typically have a significant amount of floating-rate debt in their portfolios; in an environment where rates are high, that debt should provide investors with solid returns if it performs well. So far, it has. The S&P BDC Index was up 4.91% through Oct. 30, putting the performance of BDCs ahead of the S&P High Yield Corporate Bond Index, which was up 4% over the same period. That floating-rate debt can cut the other way, too, and historically, BDC performance has been somewhat volatile. A lack of discipline with credit selection can result in loans that default or underperform due to late payments, which in turn can negatively impact performance. “We saw some BDCs falter during the pandemic because they were under pressure and needed to make changes in their portfolio,” says Patrick Linnemann, managing director at Blue Owl Capital’s credit platform. “That’s a scenario you want to avoid, and we could see it again if there’s a recession. It’s going to be important for teams to make sure they are managing risk.” The pullback of traditional banks has created a need for alternative financing sources, and BDCs are positioning themselves to fill the gap. Large firms have come to market with new BDC

We think this is going to be a very good vintage year for private credit. STEVEN RUBY Co-Head of Originated Debt, Audax Private Debt

offerings in recent months, including Ares Management, Jefferies Financial Group, T. Rowe/Oak Hill Advisors and Vista Equity Partners. “The issue is that financing is going to get more competitive, and there is limited balance sheet (capacity) available from traditional lenders,” says Linnemann. “I think private credit and BDCs are going to be an increasingly important piece of the puzzle as the market continues to grow.” BDCs and private credit vehicles are participating in ever-larger deals.

middlemarketgrowth.org

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What do you see as the biggest impediment to dealmaking in 2024? High interest rates

34.1%

Fears of a recession

13.4%

Lower valuations

19.5%

Economic uncertainty

30.3%

Regulatory scrutiny

2.7%

% of Respondents

According to a Bloomberg report, private lenders including Oak Hill Advisors, Blue Owl Capital and HPS Investment Partners teamed up in August to provide a $5.3 billion financing package to Finastra Group Holdings, a London-based financial software company. Finastra’s loan refinances existing debt that the company raised in the U.S. and European leveraged loan market. Tiseo is seeing more of these arrangements and says that Lincoln, too, is receiving calls about recapitalization. “Because the market has slowed on the M&A front, this trend is likely to persist,” she says. “There are fewer exits, and parties have to think through their capital needs and what is going to make the most sense.”

Source: ACG’s 2024 Middle-Market Outlook Survey

THE BANKING OPTION

The high-profile bank collapses last spring have made traditional lenders more cautious, and private credit firms have stepped in to do deals. But the banks haven’t walked away entirely. “We are absolutely willing to support well-managed companies. Many of them have good balance

MIDDLE MARKET GROWTH // Special Edition

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LENDING SPOTLIGHT

sheets and are trying to be opportunistic right now,” says Steve Woods, executive vice president and head of corporate banking at Citizens. “We have to be strategic. There are still limitations on what it makes sense to do, but we are committed to working with these companies to understand and support their strategic long-term vision.” Several large commercial banks have announced new ventures in direct lending to middle-market companies. At the beginning of 2023, JP Morgan set aside $10 billion to enter the world of direct lending. In September, Reuters reported that Wells Fargo was teaming up with Cerberus Capital Management for a $5 billion fund focused on direct lending to middle-market companies. According to a September Bloomberg report, Barclays, Société Générale and Deutsche Bank have also made concerted efforts to start direct lending ventures via dedicated departments or new funds. According to the report, banks don’t want to miss out on the private credit opportunity while their broadly syndicated loans business is in a lull. Big banks got burned in the leveraged lending market in 2022, and while there are incentives for them to consider smaller, mid-market loans, Gayeski says it will take time for them to reenter that market. “The too-big-to-fail banks just haven’t been in the middle market for years,” he says. “It’s going to take some time for them to build up the relationships and meaningfully compete against lenders that have been doing business in this part of the market for a number of years.” David Miller, Americas co-head of private credit within Goldman Sachs Asset Management, agrees. “We have not been competing with banks for a while now,” he says. “It seems clear that people are still pulling back following what happened with Silicon Valley Bank and others at the beginning of the year, and from a risk and regulatory perspective, it’s hard for banks to provide the leverage profile sponsors are looking for.”

A LOOK AHEAD

A big story in 2024 is likely to be refinancing. Many loans are nearing maturity and borrowers are facing tough math. Some lenders are poised to take advantage of these trends. According to data from KKR, traditional leveraged loan issuance is down through Sept. 30 at $178 billion—the lowest level since 2009. Within that issuance, KKR is seeing that the largest portion falls into the “amend and extend” category. Amend and extend arrangements typically offer companies and sponsors an additional two years before a loan matures. “The challenge for legacy portfolios is structure; this is why

underwriting discipline is so critical throughout the credit cycle,” says Ruby. “Lenders are going to have to look at their exposures and determine who can cover the cost or what needs to be done via restructuring or refinancing to address the issues. In some cases, company owners or management teams will be able to demonstrate that they are taking steps to fix problems. Other cases will be less straightforward.” A recent research note from Bank of America suggests the default rate could tick up to 5% in 2024 if financing challenges prove to be widespread. Miller adds that debt service could mean some companies have to put off acquisitions or other growth strategies,at least in the short term. “It’s just math,” he says. “Companies that were levered at 6.5x-7x two years ago are spending significantly more on debt service than what they were. And while top lines continue to grow, the operating margin hasn’t grown sufficiently to generate significant free cash flow to make acquisitions or invest in the business given higher debt costs.” For new M&A transactions, the outlook is more positive. Stuart Aronson, executive managing director and CEO of lender WhiteHorse Capital, says he’s seeing the number of deals in his inbox begin to normalize. “We normally see 160-200 deals in our pipeline on a typical Monday, and what we had on Monday was 185 deals,” he said in an interview in October. “Some of these are deals that were in market earlier in the year, and processes stalled out because of valuation or credit issues. And they’re returning to market now that those challenges have been addressed.” Aronson notes that he’s seeing leverage levels of 3x-6x, depending on the size of the company—a range that supports

middlemarketgrowth.org

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Total Debt/EBITDA —Four-Quarter Rolling Averages Total Enterprise Value (TEV)

Q4 2021

Q1 2022

Q2 2022

Q3 2022

Q4 2022

Q1 2023

Q2 2023

Q3 2023

10-25

4.0

3.8

3.9

3.7

25-50

3.9

3.8

3.7

3.6

3.4

50-100

3.8

3.9

4.0

3.9

4.0

3.8

3.9

100-250

4.4

4.3

4.2

4.3

4.2

3.9

3.7

250-500

5.4

5.2

5.4

5.1

5.2

4.9

4.6

Total

4.0

4.1

4.0

3.9

3.8

3.7

dealmaking, he says. According to ACG’s survey data, most lenders who responded anticipate that leverage levels will remain steady or fall in the year ahead. “Debt markets are getting more aggressive than they were at the beginning of (2023),” Aronson says. “But I think we’re in a range that is likely to hold because lenders will want to ensure that companies have adequate cash flow coverage. If rates come down, that may change, but it seems unlikely that will happen in the near term.” This tracks with what Hunter Davis, Aon’s co-head of M&A and Transaction Solutions for North America, is seeing from clients. “We think the bid/ask is getting more realistic, and that’s going to support activity going forward,” he says. “We’re also seeing some of our larger private equity clients engage with us on more complicated carve-out platform deals that they haven’t been doing a lot of. I think people are getting more comfortable with rates and other issues, and so we’re seeing more firms coming to the table.” Miller anticipates that private credit will continue to lead on new deals coming to market. “The deals in private credit continue to get larger. We’re seeing $1 billion to $3 billion unitranche deals, and that just didn’t exist before,” he says. “That’s a function of how much money has been raised but also maturation in the market. These are high quality deals from a credit perspective.” //

Source: GF Data’s Q3 2023 Leverage Report

BAILEY M CCANN is a business writer and author based in New York.

MIDDLE MARKET GROWTH // Special Edition 43

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INDUSTRY SPOTLIGHT

Mid-Market PE Appetite for Business Services Dips V

aluations on middle-market private equity-backed acquisitions in the business services sector faltered in the third quarter of 2023, a reversal from prior quarters since the waning of COVID, according to GF Data. Valuations on business services deals valued between $10 million and $250 million fell to an average of 7.1x trailing 12 months (TTM) adjusted EBITDA through the first nine months of last year—off nearly three-quarters of a turn of EBITDA compared to the first half of 2023. This compares to an overall average of 7.5x across all deals tracked by GF Data in the third quarter. The business services sector has been well liked by investors because of recurring revenue and a belief that many parts of business services are recession resistant. These companies previously offered an element of hope in an otherwise challenged middle market, but the new valuation data suggests confidence in the sector isn’t holding up as well as expected. All but the largest transactions in the sector notched declines from the first six months of last year, with

cohorts between $10 million and $100 million dropping between 0.4x and 0.9x compared to the three quarters ended Sept. 30. Averages on larger transactions valued between $100 million and $250 million improved by nearly a full multiple through the first three quarters compared to the first half—11.0x versus 10.2x. Overall average valuations on business services deals are still above the historical average of 6.9x, based on the GF Data database. Debt coverage on business services platforms also declined through last year’s third quarter. Total debt to EBITDA for these deals averaged 3.5x through the third quarter—in line with the historical average—and below the 3.8x average for the first half of 2023. Meanwhile, senior debt to EBITDA fell to 2.7x compared to 2.9x in the first half of last year. The declines in coverage most affected smaller platform buyouts valued between $10 million and $25 million and, to a lesser degree, deals valued between $50 million and $100 million. //

Total Enterprise Value/EBITDA—Business Services ($10M-250M TEV) TEV ($M)

2003- 2018

2019

2020

2021

2022

YTD 2023

10-25 25-50 50-100 100-250 Total N=

5.6 6.6 7.9 8.3 6.6 626

5.8 7.5 8.2 10.2 7.2 93

5.8 7.0 7.6 10.0 7.1 92

6.0 7.2 8.5 9.1 7.3 130

6.6 6.9 8.6 9.8 7.4 106

5.7 7.1 8.8 11.0 7.1 56

Total

5.8 6.8 8.1 9.0 6.9

436 325 214 128 1103

Total Debt/EBITDA—Business Services by Deal Size ($10M-250M TEV), Platforms Only

TEV ($M)

2003- 2018

2019

2020

2021

2022

YTD 2023

10-25 25-50 50-100 100-250 Total N=

3.1 3.4 3.8 4.5 3.5 404

2.9 3.1 3.7 4.8 3.5 60

2.7 3.2 2.8 4.6 3.3 51

3.0 3.3 3.4 4.1 3.5 74

3.7 3.0 3.7 4.3 3.6 60

2.6 3.6 3.0 4.6 3.5 23

middlemarketgrowth.org

05_LendingSpotlight_V2.indd 44

Total

3.1 3.3 3.6 4.4 3.5

212 204 151 105 672

Source: GF Data

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IT Services Fragmentation by Top Companies

4% IBR

Fragmentation by Ownership

Accenture

14,096 8,360 5,104 5,595

VC Backed

2% 1%

Capgemini

Private Subsidiary P Backed

87%

HCL Group

1% 4% 11% 35%

Public Independent

Cognioant

4E8,145

49%

Total Remaining

Public Comps

Mean

$85.3B

$93.9B

$21EB

$40.1B

1.8 x

10.0 x

Accenture

$204.3 B

$198.4 B

$64.1 B

$11.2 B

3.1 x

17.3 x

IBM

$13Å.2 B

$182.8 B

$61.1 B

$13.7 B

3.0 x

12.9 x

Cognizan t

$32.9 B

$32 B

$19.4 B

$3.4 B

1.7 x

9.6 x

Capgemin¤

$29.3 B

$33.4 B

$22.7 B

$3.1 B

1.Å x

10.2 x

Wipro

$24.6B

$22.7B

$917.7B

$169B

0.0x

0.1x

Private Comps

“The most common way

Sutherlan d

$5.7B - $8.5 B

67,48 5

19.1%

Perato n

$5.2B - $7.8 B

22,12 4

7.6%

Stefanini Group

$3.4B - $5.2 B

30,39 7

13.6%

iQo r

$3.4B - $5.1 B

29,25 3

9.6%

Synechron

$1.3B - $1.9B

17,918

38.3%

to find a private revenue estimate is by employee count. Grata uses proprietary data sources to create scale factors for different company types, like IT Services, to show the most accurate data possible.º

Prece ent Transactions

MCCi

11/13/2 3

GovBuil t

43.2%

Calian Group

11/9/2 3

Decisive Group Inc .

15.7%

Thrive

11/8/2 3

4IT, INC .

1,17 5

119.6%

NTT DATA Business Solutions AG

11/8/2 3

Sapphire

1,02 5

26.7%

Cience

11/8/23

Steer Campaign

1,252

-28.9%

05_LendingSpotlight_V2.indd 45

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JOIN THE NETWORK

Middle Market Growth is the official publication of the Association for Corporate Growth (ACG). ACG offers a wealth of resources to members and the broader middle-market M&A community through national and local networking events, digital and print media outlets (including this one), a robust middle-market valuation database, industry education and more. Here are some of the best resources ACG provides that can help you do your job better.

What’s in it for YOU? As a member of ACG, you gain access to the exclusive network of 15,000 middlemarket M&A professionals that we serve and benefit from the connections that ACG actively facilitates. According to our members, 75% of ACG members do deals with other members, and 86% of members are either very or extremely likely to recommend ACG to a friend or colleague.

06_RWI_V2.indd 46

Member Benefits Member-Exclusive Events and Programming: Collaborate with other members and benefit from expert panels and industry insights. ACG Member Directory Access: Search for and connect with fellow members within ACG’s exclusive directory of middle-market professionals. ACG JobSource®: Post or search for a job on ACG’s job board for middlemarket professionals. Member-Only Offers: Claim discounts and deals courtesy of ACG’s partners such as Grata, EPG and others. Check out acg.org/membership-tools/ offers-acg-partners for current offers. Print Magazine Subscription: Receive print editions of Middle Market DealMaker, Executive and special reports.

12/13/23 4:13 PM

WHAT ELSE CAN YOU DO WITH ACG? Attend an Event

DealMAX is ACG’s flagship dealmaking conference with more than 3,000 attendees, including 800 private equity investors, 675 investment banks, and more than 200 operating partners and strategic acquirers. More than 13,000 one-on-one meetings were scheduled in three days at DealMAX 2023. Check out Dealmax.org for event and registration information. ACG hosts hundreds of local chapter events annually for middle-market professionals. Whether you prefer a round of golf, wine tasting or an educational lunch, you’ll find it here. Visit acg.org/events to find out what’s happening near you.

Stay in the Know

The Middle Market Growth editorial team produces a weekly email that features thought leadership and news from around the middle market, including our PE Weekly deal roundup. Learn more and sign up to receive the newsletters at middlemarketgrowth.org/subscribe. ACG Media keeps middle-market dealmaking and operating professionals up to date on news, trends and best practices through video, with its GrowthTV channel, and audio, with the Middle Market Growth Conversations podcast. Learn more at middlemarketgrowth.org/category/news-trends.

Power Your Deals

Did you know that GF Data, a powerful middle-market private equity valuation database, is an ACG company? GF Data publishes quarterly reports on M&A, leverage and key deal terms and provides an online valuation database with continuously available valuation comps organized by NAICS industry code. Visit gfdata.com, email info@gfdata.com or call 610-6164607 for more information.

Connect

ACG operates in more than 60 local markets. Visit acg.org/ membership-tools/find-chapter to find your local chapter. You can also email us at membership@acg.org.

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06_RWI_V2.indd 48

12/13/23 4:13 PM

Reps and Warranties Insurance

Evolves with the Deal Market

While RWI pricing and underwriting have adapted to M&A trends, claims processing has proven less flexible and could affect the product’s future use BY KATIE MALONEY

Illustration by Afry Harvy

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REPS AND WARRANTIES INSURANCE

T For most traditional PEbacked industries, $100 million was a common break point. For stronger deals, however, this number is coming down. CRAIG MCCROHON Partner, Burke, Warren, MacKay & Serritella

06_RWI_V2.indd 50

he slowdown in mergers and acquisitions in 2023 has impacted the representations and warranties insurance (RWI) market by driving down prices. Although rates are expected to rebound when dealmaking picks up, changes to the types of transactions that use RWI, and how insurers approach underwriting and settling claims, are likely to outlast the chill in M&A activity. Representations and warranties insurance was first introduced more than 20 years ago to transfer risk from the parties of the deal to an insurance company and has since grown in popularity. Insurance brokerage and consultancy Woodruff Sawyer estimates that RWI is used in 64% of deals involving large strategic acquirers and 75% of private equity transactions. “For PE funds, RWI is a lifesaver,” says Craig McCrohon, partner at law firm Burke, Warren, MacKay & Serritella. “Before, funds were loath to bring a claim against the very managers who sold the company and now oversee the portfolio crown jewel. Now, PE buyers bypass the drama with the seller- manager and simply seek compensation from a third party— the RWI insurer.” When M&A activity soared in 2021, demand for reps and warranties insurance rose with it. Two years later, the market looked much different. Global M&A value fell by 44% in the first five months of 2023 compared with the same period in 2022, according to Bain & Co. Deal volume dropped by 16%, reflecting a shift toward smaller transactions. Lower deal activity translated into less demand for RWI, and insurance prices dipped. Woodruff Sawyer noted in its 2023 Guide to Representations & Warranties Insurance that, as of June 2023, standard premium rates were running at about 2% to 3% of the policy limit. (The mean policy limit amounts to about 10% of the transaction size.) That pricing for premiums is down from a recent high of 5.1% of the policy limit on average in Q1 2022, and closer to the Q2 2021 average of 3.1%. Other brokers have observed the drop in premium pricing, too. “We have seen a decline in premium rates on line for all transactions and across all industries,” says Celeste Owens, director of operations for private equity and M&A at Gallagher, a global insurance brokerage and risk management firm. “Pricing is nearing or just below what we saw pre-pandemic.” The dip in prices has prompted some RWI policy-seekers to increase their coverage amount. Eric Jesse, a partner at law firm Lowenstein Sandler, notes that he’s seen clients involved in smaller or midsize deals raise their liability limit to 15%.

middlemarketgrowth.org

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Reps and Warranties Insurance Usage Expected to Rise in 2024 Dealmakers’ forecast changes to reps and warranties insurance (RWI) usage in 2024 compared with 2023 60.2%

% of Respondents

18.8%

11.5%

10.3% 0 More deals will use RWI

Fewer deals will use RWI

RWI will be obtained earlier in the deal process

More transactions will self-insure

Source: ACG’s 2024 Middle-Market Outlook Survey

Average Rate as a % of Limit by Inception Quarter Q2 2021

3.1%

Q3 2021

3.6%

Q4 2021

4.6%

Q1 2022

5.1%

Q2 2022

4.9%

Q3 2022

4.4%

Q4 2022

3.5%

Q1 2023

3.1% 0

% of Policy Limit Source: Woodruff Sawyer’s 2023 Guide to Representations & Warranties Insurance

06_RWI_V2.indd 51

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REPS AND WARRANTIES INSURANCE

Self-insured retention (SIR) levels—the amount of loss that the policyholder must incur before RWI insurance coverage kicks in—have also fallen. Traditionally, the SIR amounted to 1% of a deal’s enterprise value (EV), but a report from Lowenstein Sandler noted SIRs as low as 0.5% of EV for deals above $500 million. A 1% SIR remains typical for deals below that threshold, although “retentions of 0.75%-0.9% of EV were also achievable while deal flow remained high,” Lowenstein’s R&W Insurance Claims Report 2023 noted.

WIDENING THE RWI TENT

As the RWI market matures, underwriters have grown comfortable with a broader swath of deals. Stephen Davidson, global co-head of litigation risk and head of claims at Aon, notes that RWI use has expanded to a broader set of deal types, including secondaries, minority investments and take-private deals. Meanwhile, use of the insurance has extended to smaller transactions. Small and middle-market M&A deals were a significant part of the RWI landscape in 2023, Davidson notes, and as a result, insurers became much more willing to underwrite smaller transactions. Insurers today are able to extend RWI coverage to some deals worth as low as several million dollars of enterprise value and to craft policies with coverage commensurate with transactions of such sizes, Davidson says. That’s a marked change from the recent past. “Previously, you wouldn’t have seen deals with an EV below $10 million to $20 million,” he says. “If you go back even further—five, six years ago—you probably wouldn’t have seen a policy that was less than $3 million to $5 million.” McCrohon, too, is seeing RWI used in some smaller deals. “For most traditional PE-backed industries, $100 million was a common break point. For stronger deals, however, this number is coming down,” he says. At the same time, he notes that the economics have to make sense, and RWI might not be a fit for all transaction sizes. “Deals with enterprise values below $50 million are still a challenge to make RWI cost-effective,” McCrohon says.

A COMMODIFIED PRODUCT

Although today’s insurers are willing to underwrite a wider range of deals, claims processing has headed in a less nimble direction. Lowenstein’s 2023 report showed that in cases where claims exceeded the amount of the self-insured retention, only 60% of respondents said that a claim payment was negotiated, down from 87% of respondents three years ago. Although RWI was developed to facilitate dealmaking transactions, a lengthier and more difficult claims process suggests RWI is losing

06_RWI_V2.indd 52

some of the features that make it attractive. “This insurance product is different than other types of insurance because it was born out of the M&A community, where people are business focused and they want to get a deal done,” says Jesse. “I think that mentality had carried over on the claims side a few years ago, but now you see the product may be becoming a little bit more like other commoditized insurance policies.” Claims filed against the RWI policy still tend to be resolved swiftly compared with alternatives, McCrohon notes, even if the process is not always seamless. “RWI is faster and often as successful as traditional indemnification protection,” he says. “However, policyholders should not confuse better, faster and cheaper with perfect, immediate and free.” As for events that trigger claims, financial statement breaches continue to be the most reported type of breach observed by Aon, but an uptick in third- party claims has driven up the number tied to compliance with laws and undisclosed liabilities, Davidson notes. Unlike first-party claims, which are brought by the insured party listed on the policy, a third-party claim originates with a party outside of the M&A transaction, such as a vendor seeking to enforce a contract, or the IRS as part of an audit. Lowenstein’s report similarly showed financial statements as the leading breach type, followed in the Top 5 by data security, privacy and IT; employee benefits; employment; and environmental-related breaches.

WHAT’S NEXT

Industry participants expect reps and warranties insurance will continue to be in high demand as M&A activity accelerates. An Association for Corporate

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Growth survey in the fall showed that 60% of middle-market respondents foresee more deals using RWI in 2024 compared with 2023. RWI pricing is also expected to increase. “The transactional risk insurance arm of a well-regarded managing general agent recently shared that they anticipate raising rates to sustain an uptick in high- severity claims which they have paid,” says Gallagher’s Owens. “We often hear this from our market leaders following an extended softening of the market. While rate hikes are not always immediate, it remains to be seen when or even if this will impact the market.” A pickup in deal flow is expected to contribute to higher RWI prices, too, but Jesse hopes carriers will keep retentions low—something that will benefit not only dealmakers but insurers themselves. “When the retention is a little bit lower, it means that the policyholder—the buyer— has quicker access to the policy limits,” he says. “I know insurers don’t want to hear this, but that’s actually a good thing for them because it means that this is a product that is actually utilized and is needed.” As for the decline in negotiated claims that Lowenstein’s report showed, Jesse describes it as a “call to action” for carriers to become more reasonable in resolving claims, in part to ensure that RWI continues to be seen as an effective tool for risk transfer. “They (policyholders) expect that when there’s a claim that comes in, that they should be paid and they shouldn’t have to be run through the ringer,” Jesse says. “The last thing you want clients to do is question why they even need R&W insurance.” // KATIE MALONEY is ACG’s content director, based in Chicago.

Types of Breaches Reported

What was/were the type(s) of breach(es) that was/were the basis of the R&W claim(s)? Financial statements

42%

Data security, privacy, IT

40%

Employee benefits

32%

Employment

28%

Environmental

24%

Compliance with laws

24%

Ordinary course operations

21%

Inventory

21%

Material contracts

20%

Supply chain

20%

Fundamental

20%

Tax

18%

Intellectual property

18% 0

% of Respondents Respondents could select more than one option. Source: Lowenstein Sandler’s R&W Insurance Claims Report 2023

MIDDLE MARKET GROWTH // Special Edition 53

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Investment Bankers Chart a

New Path Boutique and middle- market advisors are ramping up hiring, while bulge-bracket banks cut staff in a slow M&A environment BY ANASTASIA DONDE

Illustration by Solarseven

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EMPLOYMENT

A The middle market and lowermiddle market are where most deals are still happening. MATT BROM Managing Director, Clearsight Advisors

s investment bankers advance in their careers, the natural tendency is to work at ever-larger firms and on bigger deals. The incentives are obvious: larger fees and more clout. In a slow M&A year like 2023, however, some people bucked that trend and went down market instead. Matt Brom, who joined Clearsight Advisors in May as a managing director in the boutique investment bank’s Government Services, Defense and Public Sector Technology Practice, says he was encouraged by the fact that Clearsight was seeing a decent amount of deal flow in a relatively slow year. “They are still very active and have been closing a lot of deals,” says Brom. “Those in our buyer universe noted they’ve been impressed with the deal volume we’ve been able to maintain in this market.” Brom was previously a director at Truist Securities, where he’d worked since 2020. Prior to that, he spent 10 years in a variety of roles at Truist’s predecessor, SunTrust Robinson Humphrey. When BB&T and SunTrust merged and rebranded as Truist in 2019, the bank’s goal was to go after more large- cap deals and public companies. Brom says that deal flow was especially light in this category in 2023, amid a flurry of market headwinds. There were few deals in 2022 among public aerospace and defense companies. “If that was the market you were incentivized to chase, you were kind of starved,” Brom says. Smaller companies are more likely to continue trading even in a slow environment, since founder-and family-owned businesses have other motivations to sell. “The middle market and lower-middle market are where most deals are still happening,” Brom says.

WAVES OF CUTS

The lower deal volume has prompted some large bulge-bracket and larger full-service banks to lay off staff in droves. Credit Suisse let go of most of its investment bankers after it merged with UBS; several other large banks, including Goldman Sachs, Morgan Stanley and Citi, announced thousands of staff cuts over the 2022-2023 time frame. Simon Lewis, managing director and founder of SLA Executive Search, describes the cuts as having come in waves. The first wave happened at the end of 2022 or beginning of 2023, when large banks cut about 10%-15% of deal execution

middlemarketgrowth.org

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Investment Banking Base Salaries Base Compensation

Investment Banking Managing Director

Investment Banking Director

Bulge-Bracket Base Compensation

$300,000 -$450,000

$275,000 -$350,000

Elite Boutique Base Compensation

$300,000 -$450,000

$300,000 -$350,000

Middle-Market Investment Bank Base Compensation

$250,000 -$350,000

$250,000 -$300,000

Boutique Investment Bank Base Compensation

$150,000 -$250,000

$200,000 -$250,000

Investment Banking Bonus Structures Bonus Compensation

Investment Banking Managing Director

Investment Banking Director

Bulge-Bracket Bonus Compensation

20-30% or more of revenue generation

100-200% performance and origination

Elite Boutique Bonus Compensation

20-30% or more of revenue generation

100-200% performance and origination

Middle-Market Bonus Compensation

20-30% of revenue generation

100-200% performance and origination

Boutique Investment Bank Bonus Compensation

30-50%+ of revenue generation

100-200% performance and origination

Source: Selby Jennings Salary Guide: Investment Banking

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EMPLOYMENT

staff “with the understanding that the market was going to be slower,” Lewis says. Some of this was a reality check after banks hired aggressively during the dealmaking boom of 2021, he adds. After the first quarter of 2023, when it was clear deal volume wasn’t picking up, many banks conducted a second wave of layoffs involving deal execution staff, including people at the senior associate, director and sometimes managing director levels, Lewis explains. As the slow dealmaking environment continued to drag on, some banks engaged in a third wave of cuts. “These were people that they didn’t want to lose but had to let go of” to cut costs, Lewis says. About 300 middle-market investment bankers at the managing director or director level changed jobs in 2023 through September, according to SLA’s estimates. More announcements about investment banking hires—most of them from boutique and middle market- focused banks—began to crop up in the second half of the year.

A LIFESTYLE CHANGE

Smaller banking firms aren’t always able to match larger competitors’ base pay levels, but experienced bankers can still make similar amounts—if not more—at boutique firms with less overhead, experts say. Brianne Sterling, head of corporate and investment banking at financial services talent firm Selby Jennings, says some boutique banks can offer a better work-life balance, stability and culture. Bankers moving from bulge-bracket or larger boutique outfits to middle-market firms effectively become “big fish in a small pond.” “These firms can give the banker not only whiteboard space in their sector but also more transparency on compensation,” says SLA’s Lewis. There is often more autonomy and less bureaucracy at these organizations, he adds. Ramsey Goodrich, managing partner at Southport, Connecticut- based investment bank Carter Morse & Goodrich, says the change is “a lifestyle question as much as a financial one.” “If you close a few deals, you’ll actually make more money. But you might not have the fancy Wall Street brand name, the lavish perks or the full staff of junior professionals” often offered at large banks, Goodrich says. His firm works with multigenerational family businesses to prepare them for an eventual sale, which often takes several months, if not years. “Private equity-backed companies are built to sell. Family businesses are typically built to hold,” says Goodrich, “so the time to prepare just takes longer.” With all the bankers who have been laid off over the last few months and the slowdown in M&A, smaller boutiques like Goodrich’s

I’ve been talking to bankers and since Labor Day, pitch activity is up, especially in sectors where there's strong private equity interest, such as industrials, business services, and food and beverage. SIMON LEWIS Managing Director and Founder, SLA Executive Search

middlemarketgrowth.org

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How do you expect the staff size at your firm to change in 2024 compared with 2023?

We plan to add headcount

63.3%

We expect headcount to remain the same

36.7%

We plan to decrease headcount

0% 0

% of Respondents

firm have “had a pick of the litter,” he says. “These are people who we wouldn’t traditionally have had access to, but we have been investing for the future—which is right around the corner.” Carter Morse & Goodrich recently hired a vice president in M&A execution, John Papadopoulos, who was previously an associate director at UBS’ investment bank in the Global Industries Group. Goodrich says he plans to continue to add more staff at the associate level in the next few months.

Source: ACG’s 2024 Middle-Market Outlook Survey Based on responses from 49 investment bankers who took the survey.

PREPARING FOR THE REBOUND

As M&A started to slowly rebound in the third quarter of 2023, banks wanted to be well positioned for the recovery. Some have been hiring opportunistically in more active subsectors like healthcare; aerospace, defense and government services; industrial technology; and transportation and logistics technology, Lewis says. Activity in consumer, manufacturing and auto has been on the decline, however. These have become areas where banks aren’t spending as much time right now. Debt advisory specialists at boutique banks who help buyers line up nontraditional financing through private credit or club deals are also in demand, Lewis says. Above all, firms are interested in hiring senior managing directors with a track record of delivering deal flow. Selby Jennings’ Sterling says firms are looking for bankers who have closed more transactions and “will be able to plug-and-play” easily into their new employer’s workflow. Lewis thinks middle-market banks will continue to ramp up hiring in 2024 as deal flow improves. “I’ve been talking to bankers and since Labor Day, pitch activity is up, especially in sectors where

MIDDLE MARKET GROWTH // Special Edition

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EMPLOYMENT

there’s strong private equity interest, such as industrials, business services, and food and beverage,” he says. Even if the macro environment and interest rates aren’t as favorable for dealmakers, investors can’t sit on the sidelines for too long. “Firms are now thinking: We want to be best positioned for a rebound,” Lewis adds. Stephen Rossi, managing director and head of investment banking at Los Angeles-based Palm Tree, says his firm is staffing up in preparation for an uptick in deal flow. In September, Palm Tree hired Tracy Albert as vice chairman of investment banking and David Barnes as a managing director and head of mergers and acquisitions. They previously held senior investment banking roles at JD Merit & Co. in Seattle. “We have more active engagements driving the need for growth,” says Rossi. “We anticipate the market picking up as we roll into 2024.” He says there are increasing opportunities for special situations activity as some companies struggle to cope with rising interest rates. “Sellers are also getting comfortable with the new paradigm,” and it’s become easier for buyers and sellers to agree on valuation, says Rossi. Out of 49 investment bankers who took ACG’s annual survey in the fall, 71% said that they expect to see more deal activity in 2024 as compared to 2023. A majority of the bankers polled (63%) said they expected to add headcount in 2024, while 37% expected headcount to remain the same. None said they plan to reduce their staff size.

GEOGRAPHIC MIGRATION

Experts are also noticing geographic trends in banking talent. “New York, San

Recent Investment Banking Hires Baird hired RO BHANDARI and BEN PORT as managing directors in the Healthcare Investment Banking Group, with Bhandari focusing on medical technology and Port on provider services. The two were previously at rival investment banks: Bhandari joined from William Blair and Port from Moelis. Brown Gibbons Lang & Co. appointed PETER FINN as a managing director to lead its Industrial Technology Investment Banking Team. He was previously a managing director at TD Cowen, leading the Industrial Technology Practice there. Carter Morse & Goodrich added JOHN PAPADOPOULOS as a vice president focused on M&A transaction execution. He was previously an associate director at UBS in the Global Industries Group. Cascadia Capital tapped RON RIVERA as a managing director in its Software/Technology Group. He joined from technology advisory firm Drake Star Partners. Clearsight Advisors hired MATT BROM as managing director to lead its Government Services, Defense and Public Sector Technology Practice and STEPHEN SHANKMAN as a managing director to oversee the Information Services Practice. Brom was previously a director at Truist Securities, while Shankman joined from Jegi Clarity, a technology, media and telecommunications M&A advisory firm. Harris Williams hired MICHAEL KIM as a managing director and co-head of the Technology Group. He previously served as global head of technology investment banking at Piper Sandler.

middlemarketgrowth.org

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MMG23

Thank You to ACG’s Official Sponsors of Growth

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EMPLOYMENT

Francisco and Chicago were the hot spots for investment banking, but now there is a lot of growth in Atlanta, Los Angeles, Austin and Miami,” says Lewis. During the pandemic, many people moved away from big cities or to the South, and now bankers are often open to working in other locations. Selby Jennings’ Sterling says, “There are a few cities that are attractive to bankers, some of which have fully remote options and others where you come in once in a while.” Firms are also open to starting offices at new locations or hiring a managing director where he lives and building an office around him. Sterling agrees that cities like Miami, Atlanta and Dallas are attractive to bankers, due to their lower cost of living. Palm Tree, which has 20 people in its investment banking group and offices in Los Angeles, Chicago, Dallas and Detroit, plans to add more investment banking staff to ramp up industry specialization over the next several years. The firm announced a new Dallas office in September. Rossi says the firm already has specialists in sectors like industrials, consumer and tech-enabled services but plans to divide up the specialties further into subsectors. Rossi says the candidates the firm talks to are often either working in another area of finance and want to try something different, or they have been laid off from bulge-bracket banks. Others are motivated by geography. “Some people wound up elsewhere because of the pandemic, and now that companies are calling people back to the office, they don’t want to move back to their prior locations,” Rossi says. //

Recent Investment Banking Hires Houlihan Lokey appointed NICK PAVLIDIS as a managing director for its Consumer, Food & Retail Group. He was previously a managing director in the consumer sector at Baird. Oppenheimer & Co. added RUPERT SADLER as a managing director in the firm’s Technology Investment Banking Group. He was previously a managing director in the Global Technology Group at Houlihan Lokey. Palm Tree added TRACY ALBERT as vice chairman of investment banking and DAVID BARNES as head of mergers and acquisitions. The duo previously held senior investment banking roles at JD Merit and Co. Raymond James tapped ERIC FRANCOIS as a managing director and RYAN LESSARD as a director in its Healthcare Investment Banking Group. Francois was previously the CFO of biotech company Scynexis, while Lessard held biotech- focused investment banking roles at Evercore and Jefferies. Stephens added PETER GRANT as a managing director and head of technology. He was previously co-head of software investment banking at Cowen. William Blair hired JEROME WALLACE and BRIAN WILLIAMS as managing directors and co-heads of the bank’s Private Capital Advisory business. Both hail from Credit Suisse, where they were on the leadership team of the Private Funds Group.

ANASTASIA DONDE is Middle Market Growth’s senior editor.

middlemarketgrowth.org

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